Business context and reporting period
National Fuel Gas Company is an integrated energy company with five reporting segments: Exploration and Production, Pipeline and Storage, Gathering, Utility, and Energy Marketing. Its assets are concentrated in western New York and Pennsylvania, with Appalachian natural gas development focused on the Marcellus and Utica shales; it also produces oil, primarily in California. This Form 10-K covers the fiscal year ended September 30, 2017. Fiscal fourth-quarter results are for the three months ended September 30, 2017.
Financial performance and position
- Revenue: $1.580 billion for fiscal 2017, up 8.8% from $1.452 billion in 2016.
- Profit: Net income available to common stock was $283.5 million, or $3.32 basic EPS ($3.30 diluted), versus a net loss of $291.0 million, or $3.43 loss per share, in 2016. Fourth-quarter revenue was $286.9 million and net income was $45.6 million, or $0.53 per basic and diluted share.
- Operating income and margins: Operating income was $552.8 million, compared with an operating loss of $416.5 million in 2016. Operating margin was approximately 35.0% in 2017; the year-over-year comparison is heavily affected by prior-year oil and gas impairment charges. Utility gas costs are generally recovered from customers and are not a direct source of profit.
- Cash flow and investment: Cash from operations was $684.3 million, up from $589.0 million. Capital expenditures were $450.3 million; operating cash flow less capital expenditures was approximately $233.9 million. Cash and temporary investments ended the year at $555.5 million. Common dividends paid were $139.1 million.
- Debt and liquidity: Long-term debt, including the current portion, totaled $2.384 billion in principal; cash less debt was approximately negative $1.828 billion. No short-term borrowings were outstanding at year-end. The company had a $750 million revolving credit facility through December 2019, and reported a facility debt-to-capitalization ratio of 0.58. Management considered liquidity adequate for known demands.
- Capitalization: Shareholders’ equity was $1.704 billion and total assets were $6.103 billion. The annual dividend declared was $1.64 per share.
Material changes versus the prior year
- Net income improved by $574.5 million, primarily because the $948.3 million pretax ($550.0 million after-tax) oil and gas property impairment recorded in 2016 did not recur. Exploration and Production earnings rose from a $452.8 million loss to $129.3 million of income.
- Exploration and Production revenue rose modestly to $614.6 million. Natural gas production increased to 157.1 Bcf from 143.5 Bcf, aided by fewer price-related curtailments; lower oil production and lower hedged oil and gas prices partly offset the benefit.
- Gathering earnings increased to $40.4 million from $30.5 million, reflecting higher volumes. Pipeline and Storage earnings declined to $68.4 million from $76.6 million, primarily due to lower transportation revenues, rate reductions and higher operating expenses.
- Utility earnings declined to $46.9 million from $51.0 million despite higher usage and a new New York rate order. Energy Marketing earnings fell to $1.5 million from $4.3 million, mainly due to lower margins.
- Operating cash flow increased, while capital expenditures declined to $450.3 million from $581.6 million. Year-end cash rose to $555.5 million from $130.0 million, including proceeds from a September 2017 debt issuance.
Outlook, management commentary, risks and unusual items
- Spending and funding outlook: Estimated fiscal 2018 capital expenditures are $610 million, including $320 million for Exploration and Production, $125 million for Pipeline and Storage, $70 million for Gathering and $95 million for Utility. Management expects to rely first on cash on hand and operating cash flow and may issue short- or long-term debt as needed.
- Northern Access 2016: FERC approved the approximately $500 million pipeline project, but New York denied key water-quality and other permits. The company is challenging the denials in court and before FERC and remains committed to the project, but has not set an in-service date. Approximately $75.8 million had been spent by year-end; management found no impairment necessary at that date, while warning that an unfavorable outcome could lead to impairment of a significant portion of the costs.
- Commodity and reserve exposure: Exploration and Production results and asset values remain sensitive to oil and gas prices, regional price differentials, production levels and transportation capacity. The oil and gas ceiling-test cushion was $286.4 million at year-end; the filing’s price sensitivities still showed a cushion under the specified downside cases, but reserve and cost changes could also affect the calculation. The company hedges a portion of expected production, which limits some downside exposure but also constrains gains from rising prices.
- Regulatory matters: A New York rate order effective May 1, 2017 authorized a $5.9 million annual increase, below the requested $41.7 million; the company appealed portions of the order. An earnings-sharing mechanism is to begin April 1, 2018. The Pennsylvania division’s delivery rates were last approved in 2006. Pipeline companies’ rate settlements require future rate-case filings by 2019 for Supply Corporation and 2021 for Empire.
- Debt refinancing: In September 2017, the company issued $300 million of 3.95% notes due 2027 and used the proceeds to redeem $300 million of 6.50% notes in October 2017. This refinanced debt that otherwise matured in April 2018.
- Other risks and contingencies: The filing highlights environmental and pipeline-safety regulation, project permitting, hydraulic-fracturing rules, cybersecurity, credit-market access, interest rates, benefit-plan costs and commodity-hedge counterparty exposure. A PaDEP draft penalty concerning an alleged 2011 gas-migration violation was described as not material; Seneca disputes the allegation. Environmental cleanup costs for former manufactured-gas sites were estimated at $3.1 million, with expected rate recovery.
- Unusual accounting and tax items: Fiscal 2017 included a $31.9 million cumulative retained-earnings adjustment from adopting stock-compensation accounting guidance. Federal tax reform legislation had been introduced after year-end; its potential effect was not yet clear. The filing reports no material 2017 oil and gas impairment charge.
Important facts for investors to verify
- Progress and legal outcomes for Northern Access 2016 permits, project timing, remaining costs and any potential impairment.
- Whether fiscal 2018 capital spending and planned project commitments can be funded from operating cash flow, cash balances and available borrowing capacity.
- Oil and gas price assumptions, regional differentials, reserve revisions and the ceiling-test cushion, including the development schedule and costs for proved undeveloped reserves.
- Actual segment earnings and cash generation, particularly whether Exploration and Production and Gathering growth offsets weaker Pipeline and Storage, Utility and Energy Marketing results.
- Debt maturities, covenant headroom, credit ratings and the effects of the 2017 refinancing and any future borrowing.